By David Leffler, Esq.
By David Leffler
First published 11/17/2016; YearOfDisruption.com; publisher: GiantPeople.
You’ve accepted some invitations to serve on the advisory boards of promising startups and now have only to share a few pearls of wisdom before the stock options you agreed to in payment will be worth millions.
But wait, what about that advisory board agreement? Did you read it before signing? Did you have a lawyer review it? You may be getting a lot less than you think. In fact, you may be walking into a legal landmine.
Advisory board agreements are more than boilerplate – they have real world consequences. You may be in trouble when you violate an overly restrictive non-compete provision. Or you may find yourself without any compensation after years of service because of esoteric compensation provisions that permit the company to cancel your options.
Many problem provisions exist in advisory board agreements today. I have found one or more of these provisions in almost every advisory board agreement that I have reviewed. Don’t sign an advisory board agreement until you have checked for these and any other potential problems in the document.
Landmine #1: Advisory board agreements often contain a non-compete clause. A non-compete clause limits your activity outside of your advisory board role. In very broad terms, it prohibits you from competing with the company that you are advising.
Some non-compete provisions are relatively benign, but many are overreaching and have terms that almost guarantee a violation. You may discover that you will lose your entire compensation even with a single violation of the advisory board agreement, and the non-compete provision can be a real minefield. For example:
“Consultant agrees that during the term of this Agreement, Consultant will not engage in any employment, occupation, consulting or other business activity directly competitive with or related to the Company’s businesses, and will not assist any other person or organization in competing with the Company or any of its parent, subsidiaries or affiliates or in preparing to engage in competition with such businesses of the Company or any of its parent, subsidiaries or affiliates.”
What is wrong with this? Plenty. The provision is so extraordinarily broad that it would be hard not to violate it. First, what does “directly competitive with or related to the Company’s businesses” mean? Let’s say that the Company is in the business of media production. Does that mean the advisor is prohibited from working with any company that engages in media production? Odds are that this individual was chosen to be an advisor because he or she currently works at a media production company or as a freelance consultant in the industry, which puts the advisor at great risk of violating this provision.
What if the Company only engages in media production for online children’s films? If there is going to be a non-compete clause, shouldn’t it be limited to this area of activity? And perhaps it should be limited even further to the specific market in which the company does business.
Finally, what if the business of the company changes during the term of the advisory board agreement (commonly two years)? It is not unusual for a young company to “pivot” upon discovering that it misjudged a market. As written, the non-compete will cover that new area of business as well, something advisors don’t even contemplate.
Landmine #2: The company you’re advising ends up owning your inventions.
What if you serve as an advisor to a company doing business in the field where you have an established reputation and attained considerable success in growing companies and coming up with innovative techniques and applications? If you continue your work during your time as an advisor the agreement may require you to hand over any inventions you develop during that time.
Don’t believe me? Here’s a provision from an advisory board agreement that may raise the hairs on the back of your neck:
“During the term of this Agreement, Consultant agrees that all inventions which Consultant makes, conceives, reduces to practice, develops, establishes or contributes to and which (i) relate to the business of the Company or any of the products or services being developed, manufactured or sold by the Company or which may be used in relation therewith, (ii) result from task assigned to the Consultant by the Company or (iii) results from the use of premises of personal property (whether tangible or intangible) owned, leased or contracted for by the Company shall be assigned to the Company. The Consultant hereby assigns such inventions to the Company.”
The clauses numbered (i) through (iii) are separated by “or” which means that all the advisor has to do is satisfy one of these provisions to be obligated to assign over any rights to inventions that he or she may have developed. The first provision only requires that the advisor come up with an invention that relates to “the business of the Company or any of the products or services being developed, manufactured or sold by the Company or which may be used in relation therewith” to be required to assign all rights to the Company. It doesn’t matter that the advisor may have developed the invention on his or her own time with his or her own resources, or even when working for another company. The advisor still is obligated to assign the rights to the invention to the Company.
By signing the agreement, an advisor may unknowingly have handed over inventions worth far more than he or she would have earned from the advisory board position.
The lesson here is never to agree to such a provision, and only agree to assign rights to inventions that the advisor has developed specifically for the company he or she is advising.
Landmine #3: Compensation for advisory board members typically is not paid in cash, but in some form of equity compensation. The devil, however, is in the details.
One form of equity compensation is a profits interest, which gives the advisor an interest in the company’s profits on a going forward basis. On the date of issuance, profits interests are worth nothing, so the advisor earns no income and no tax is due.
But besides the risk that the company may never make any profits, what if the bus pulls away and leaves you by the roadside?
Startups often begin as limited liability companies but convert to a corporation prior to a financing. If at the moment of conversion the company has not been profitable, unless otherwise provided, the profits interest ends and there is no payout. That is the party bus pulling away, leaving you by the roadside.
Imagine putting in a couple years of advisory work only to learn that your compensation, a profits interest, evaporates just before the next round of financing. Don’t agree to accept a profits interest unless you have a clause in the advisory board agreement stating that the company will carry the profits interest over to the corporation should such a conversion take place.
There are a couple of reasons why these inappropriate provisions are pervasive in advisory board agreements.
First, they may be lifted wholesale from employment agreements and inserted into advisory board agreements even though the relationship of an advisor to a company is quite different from that of an employee. Also, compensation for advisory positions typically is paid in equity, not cash, so the advisor will have to pay a lawyer out of pocket to review the agreement, which often means legal vetting does not occur. Finally, receiving equity makes the agreement somehow seem less serious and less in need of scrutiny by a professional third party. Nothing could be further from the truth.
Advisory board agreements contain many substantive provisions. Give them serious consideration before signing.
David Leffler maintains a law practice representing business owners in New York City and can be reached at email@example.com.